Non-Payment Insurance Policies – Drafting Tips for Policyholders | Sullivan and Worcester
In the latest edition of Sullivan’s webinar series, Marian Boyle, Head of Insurance and Dispute Resolution at Sullivan’s London office, discussed the key clauses found in Comprehensive Non-Payment Assurance (NPI) Strategies. She gave policyholders practical advice on what to look for in NPI formulations and provided examples of how the obligations imposed by NPI policies can impact the functioning of the underlying credit risk that they assure.
NPI policies provide indemnity in the event of non-payment for any reason (except those expressly excluded). If written appropriately, NPI policies allow policyholders to manage risk and expand their financing capacity/supply using these highly effective credit support instruments.
The legal landscape
Although NPI policies are subject to the general principles of English contract law, they are also governed by a set of common law laws and principles specific to insurance contracts. How these rules work in practice is not always obvious from a simple reading of the contract. So when underwriting NPIs, understanding the legal framework within which all of these policies operate is key to ensuring that the risk transfer relied upon is as robust as possible.
As with other contracts in English, any NPI policy should be interpreted objectively by asking what a reasonable person, with all the basic knowledge that would be reasonably available to the parties when they entered into the contract, would have understood the language of the contract as signifier. Evidence of what a party subjectively intended, or understood the contract to mean, is irrelevant.
The insurance clause
The insurance clause describes the risk that the insurers will cover. It should always be read in conjunction with the policy exclusions (see below). It is important that it is clear when a loss will be deemed to have occurred.
It is also important to ensure that the insurers indemnification trigger is appropriate for the financing transaction being covered. The loss trigger for non-payment in a term loan is very different from structures where the insured participates between the direct lender and the policyholder. Similarly, if what is insured are potential losses under a receivables purchase agreement, the loss trigger will need to be worded differently.
The exclusion clauses define the circumstances in which cover will not be provided, even if the losses would otherwise be covered by the insurance clause. NPI policies could, for example, exclude cover where the non-payment is caused by a breach by the policyholder of a clause in the finance agreement, or where the loss is caused by a fraudulent or illegal act. of the policyholder.
Any exclusion should be carefully considered to ensure that the scope does not unreasonably compromise the extent of coverage. The exclusion trigger should also be carefully considered. Exclusions drafted to apply even if the matter excluded is only remotely related to the loss suffered may unacceptably reduce the scope of coverage.
The term warranty has a very specific meaning in the context of insurance law. These are conditions that must be strictly observed, whether or not they are significant in relation to the risk. In the event of a breach of warranty, the consequences for the insured are serious. Except in limited circumstances, insurers will be exempt from liability for any loss arising or attributable to anything that happens during the period the insured is in breach of coverage.
NPI policies may require the policyholder to warrant, for example, that the debtor’s payment obligations under the facility agreement that is insured are enforceable. If it turns out that this is not the case, insurers may very well consider themselves risk free.
If a guarantee is capable of remedying such that the risk to which the guarantee relates, once the breach has been corrected, becomes essentially the same as that originally contemplated by the parties, insurers will reverse the risk. At present, there is little guidance as to how English courts will interpret these relatively new provisions imposed by the Insurance Act 2015 (2015 Act). Given the potential impact on coverage, it is essential that policyholders carefully consider the precise form of guarantees and assess how practical it will be to adhere to them over the life of the policy.
Where a policy condition is expressed as a condition precedent to the risk arising, the insured risk will not apply until the condition is satisfied. If a condition in a policy is expressed as a condition precedent to the liability of the insurer, then, if the condition is breached, the insurer shall have the right to refuse liability. Unlike warranties, a breached condition precedent cannot be cured. So the practical advice, as with guarantees, is to carefully consider the scope of any condition precedent and assess the likelihood of a breach occurring and how that risk might be managed.
NPI policies are likely to contain provisions relating to the duty of fair presentation of the policyholder. The obligation arises each time a new insurance policy is taken out or when an existing policy is modified. Failure to properly discharge the duty of fair presentation may lead to avoidance of the policy by insurers. It is therefore important that policyholders are fully aware of the extent of the fair presentation obligation. It is governed by Part 2 of the 2015 Act, which is widely recognized as having extended the disclosure burden to policyholders.
Like the new legislation relating to guarantees, there is to date no case law clarifying the areas of uncertainty arising from the drafting of the 2015 law. These uncertainties can, however, be resolved by agreement between the parties.
The main purpose of any fair presentation clause in NPI policies should be to ensure that the scope of the fair presentation obligation is clear and that, from a practical point of view, the policyholder is able to comply with it. More details on this topic can be found in our previous presentation.
Terms and conditions
The general conditions are considered to be distinct from the exclusions, warranties and conditions precedent. The breach by the policyholder of a general condition in most cases is likely to give rise to a claim for damages only in the event that the insurers can demonstrate that they have suffered damage as a result of of the breach. However, many of the terms and conditions of NPI policies will affect the policyholder’s management of the underlying transaction during the term of the policy. It is therefore important that anyone responsible for the operation of the establishment is aware of these conditions and the effect they may have on the freedom of action of the insured. These clauses include:
NPI policies will require notification to insurers if there is a request to reschedule an insured payment. Deferral requests may need to be processed quickly in order to achieve the best outcome. The policy should clarify what action a policyholder is allowed to take in the event of inconsistent or delayed decisions from insurers.
NPI policies are likely to provide that acceleration of the underlying loan does not give rise to an automatic obligation for insurers to pay a claim on an accelerated basis. The general position is that the policy will only pay out on the original due date, unless the insurers agree otherwise.
Changes to the insured loan
NPI policies will provide that a policyholder cannot agree to change the underlying financing without the consent of the insurers. Often, this prohibition is framed as a guarantee. It is essential, on a practical level, that policyholders have a system in place to ensure that insurers are consulted before any changes to the terms of the insured loan are agreed.
Notification of circumstances
The obligation to inform insurers of the occurrence of a loss or of circumstances likely to lead to a loss is common in NPI policies. Any imposed delay must be carefully managed. The aim is to enable insurers to be involved at an early stage in decisions regarding loss mitigation measures.
NPI policies are likely to contain a general condition requiring the insured to take all reasonable steps within their power to prevent or minimize loss. Such clauses often require consultation with insurers regarding the proposed measures. Reasonable steps could be deemed to include realization of security or initiation of legal proceedings against the debtor.
NPI policies may contain fixed time limits within which insureds must submit a claim after the date of default. Most policies have fairly long waiting periods or loss assessment periods which specify the time that must elapse from the date the loss occurs before a loss payment is due from the insurers.
Obligation of confidentiality
Many NPI policies require policyholders to maintain strict confidentiality regarding the existence and terms of the policy. These clauses are generally exempted for disclosure to the insured’s own professional advisers and regulators.
There is no substitute for carefully reading the terms of the policy. An insurer’s agreement to indemnify under an NPI policy is subject to compliance with the policy’s key terms and conditions.
When considering a policy, assess whether the proposed operational obligations are manageable. Policy terms stress testing should include a detailed assessment of whether a robust system can be put in place to ensure compliance with policy terms and conditions. Anyone responsible for the operation of the insured establishment should be aware of the effect these conditions have on limiting freedom of action.
Click on here for a link to a video of the webinar.